Over the last decade, crypto founders have adopted a model in which value accrues to two separate instruments: tokens and equity. Tokens offer a new tool to grow networks bigger and faster than ever before, but only if they represent something users actually want to own. Unfortunately, regulatory pressure from a hostile SEC largely stopped founders from driving value to tokens, pushing them to focus on equity. It’s time for that to change.

The key innovation unlocked by tokens is self-sovereign ownership of digital property. Tokens uniquely enable holders to own and control their money, data, identity, and the onchain protocols and products they use. To maximize that potential, tokens should capture value that lives onchain — revenue and assets that are transparent, auditable, and directly owned and controlled by tokenholders alone.

Offchain value is different. Since tokenholders cannot directly own or control offchain revenue or assets, those should accrue to equity, not tokens. Founders may wish to share offchain value with tokenholders, but doing so is often inappropriate since companies that control offchain value typically have a fiduciary obligation to keep it for shareholders. If founders want to direct value to tokenholders, then that value must be onchain from the outset.

This basic distinction — tokens for onchain value, equity for offchain value — has been distorted by regulatory pressure since the very beginning of crypto. The old SEC’s overbroad views of securities law misaligned incentives between companies and tokenholders, and forced founders to rely on decentralized governance systems that were poorly suited to manage protocol development. Now, founders have a fresh opportunity to explore what tokens can do.

In the ICO era, crypto companies often raised capital through public token sales with no regard for equity. They sold tokens on the promise that building a protocol would make the tokens more valuable after launch — the token sale was the sole fundraising event, and the token was the sole value-accruing asset.

But ICOs did not survive SEC scrutiny. Starting in 2017 with the DAO Report, the SEC applied the Howey test to public token sales and found many to be securities. In 2018, Bill Hinman pinpointed “sufficient decentralization” as the key to compliance. In 2019, the SEC published a sprawling framework of factors that increased the chance of a securities designation.

In response, companies abandoned ICOs in favor of private equity raises. They used venture capital to fund protocol development and then distributed tokens only after their work was complete. To comply with SEC guidance, they had to avoid post-launch efforts that might boost token value. The SEC’s views were so restrictive that companies essentially had to walk away from the protocols they built — they were even discouraged from holding tokens on their balance sheets to avoid the appearance of a financial motive to generate token value.

Founders ceded protocol governance to tokenholders and turned to building proprietary products on top instead. The idea was that token-based governance would provide a shortcut to sufficient decentralization, and founders could then contribute to the protocol as one of many in a broad ecosystem of participants. Founders could also build equity value through a commercial strategy of “commoditizing the complement” — giving away open-source software for free and then monetizing a product on the layers above or below.

Yet, this model created three major problems: misaligned incentives, ineffective governance, and unresolved legal risk.

First, it misaligned incentives between companies and tokenholders. Companies were pushed to drive value to equity, not tokens — both to mitigate regulatory risk and to satisfy fiduciary duties owed to shareholders. Rather than compete for market share, founders had to develop business models that prioritized equity value, or forgo a business model altogether.

Second, it depended on DAOs to manage protocol development, which they were ill-suited to do. Some DAOs used foundations, which often suffered from their own incentive misalignment, legal and economic constraints, operational inefficiencies, and centralized gatekeeping behaviors. Other DAOs used collective decisionmaking, but most tokenholders proved to be uninterested in governance, and coin voting led to slow, inconsistent, and poor outcomes.

Third, it failed to protect companies from legal risk. Although it was designed as a regulatory compliance strategy, the SEC still investigated companies that used it. Token-based governance also introduced new legal risks, such as the possibility that DAOs could be treated as general partnerships, exposing tokenholders to unlimited joint and several liability.

In the end, this model’s promised benefits were outweighed by its costs, undermining both the commercial viability of protocols and the market appeal of their related tokens.

The new regulatory environment opens the door for founders to revisit the proper relationship between tokens and equity: tokens should capture onchain value and equity should capture offchain value.

Tokens are unique in their ability to convey self-sovereign ownership of digital property. They grant holders ultimate ownership and control over valuable onchain infrastructure, which is transparent and auditable in real-time by anyone in the world. To make the most of that ability, founders should design products so that value flows onchain, where tokenholders can own and control it directly.

Examples of onchain value-capture include mechanisms like Ethereum’s EIP-1559, which burns protocol fees to benefit tokenholders, or fee switches that redirect DeFi protocol revenue to onchain treasuries. Tokenholders could also receive revenue from intellectual property rights that they own and license to third parties, or from DeFi front-end interfaces that route all of their fees onchain. What matters is that the value is transacted onchain, where it can be directly observed, owned, and controlled by tokenholders without relying on an intermediary.

Offchain value, by contrast, should accrue to equity. When revenue or assets exist offchain — in bank accounts, business relationships, or service contracts — they cannot be directly owned or controlled by tokenholders. Instead, tokenholders must rely on a company to intermediate the flow of value. That relationship is likely subject to securities regulation. Also, companies that control offchain value may have a fiduciary duty to return it to shareholders, not tokenholders.

This does not mean that having equity is a problem. Crypto companies can still succeed by using traditional business strategies, even when their core product is open-source software like public blockchains or smart contract protocols. As long as companies clearly separate onchain value for tokens and offchain value for equity, they can generate real value for both instruments.

In this new era, founders should stop treating token-based governance as a shortcut to achieve regulatory compliance. Instead, founders should employ governance only when necessary, and even then, it should be minimized and organized.

One of the core advantages of public blockchains is automation. In general, founders should automate everything they can and reserve governance only for what they cannot. Some protocols may benefit from having “humans at the edges” for tasks like implementing upgrades, allocating treasury funds, and overseeing dynamic parameters such as fees and risk models. But governance should be limited to tasks that tokenholders are uniquely suited to handle. All else equal, the more automation, the better.

Where full automation is impossible, delegating specific governance powers to trusted teams or individuals can improve the speed and quality of governance. For example, tokenholders might delegate the power to change certain protocol parameters to the company that built the protocol, enabling rapid changes without requiring full consensus and a vote for each and every one. As long as tokenholders retain ultimate control — including the ability to monitor, override, or revoke those powers at will — delegation can serve as an effective tool without sacrificing the principles of decentralization.

Founders can also set up governance to succeed with purpose-built legal structures and onchain tooling. Founders should consider organizing governance under new entity structures like the Wyoming DUNA, which provides tokenholders limited liability and legal personhood so that they can enter contracts, pay taxes, and enforce their rights in court. Founders should also consider governance tools like BORGs, which enable DAOs to carry out tasks with the benefit of onchain transparency, accountability, and security.

Meanwhile, founders should maximize tokenholder ownership of onchain infrastructure. The market has shown that users place little value on governance powers — few will pay for the ability to vote on protocol upgrades or parameter changes. But they do value ownership in the form of ultimate control over revenue and other onchain assets.

To address regulatory risk, tokens must be clearly distinguished from securities.

The key difference between securities and tokens lies in the rights and powers that each instrument conveys. In general, securities convey a bundle of rights tied to a legal entity, such as economic rights, voting rights, information access rights, or legal enforcement rights. For example, stocks give holders specific ownership rights tied to a company, but those rights begin and end with the company — if the company fails, the rights are worthless.

Tokens, by contrast, convey a set of powers over onchain infrastructure. Those powers exist outside the boundaries of any legal entity, including the company that created the infrastructure — the company can fail, but the powers conveyed by the token will persist. Unlike securities holders, tokenholders are owed no fiduciary duties and have no legal rights by default. The property they own is instantiated in code and economically independent from its creator.

In some cases, onchain value may depend in part on the success of a company’s offchain efforts. But that fact does not necessarily trigger the securities laws on its own. While the statutory definition of a security is meant to be broad and flexible, it is not meant to regulate every relationship where one party relies on another to generate value.

Many commercial transactions involve some form of profit dependence without falling under securities regulation. The buyer of a luxury watch, a limited-edition sneaker, or a high-end handbag may expect those assets to appreciate in value based on the brands’ continued success, but those transactions are not regulated by the SEC.

The same is true for countless commercial contracts where one party depends on another to provide value. For example, a landlord may rely on a property manager to maintain a property, attract tenants, and generate revenue, but that reliance does not make the landlord an investor in a security. The landlord retains full ownership and control — it can override the manager’s decisions, replace the manager at will, and hire others to do the same work. Its powers over the property exist independently of the manager and persist regardless of the manager’s success.

Tokens designed to capture onchain value are more like these assets than traditional securities. When holders acquire tokens of this sort, they know exactly what property and powers they own and control. They may expect the value of that property to grow based on a company’s ongoing efforts, but they have no legal rights related to the company, and their ownership and control of their property is entirely independent of the company.

Ownership and control of digital property should not create the kind of relationship that warrants securities regulation. The principal rationale for applying securities law is not simply that one party benefits from another’s efforts, but rather that an investor relies on an entrepreneur in a relationship marked by information and power asymmetries. Absent such a relationship, transactions in tokens conveying property rights should not be characterized as securities. 

Of course, just because securities law should not apply to these tokens does not mean that the SEC or private plaintiffs will not allege that it does, and perhaps successfully depending on how courts interpret the law. But new U.S. policy developments may soon validate the distinction between tokens and securities. Both Congress and the SEC are considering frameworks that shift the focus away from ongoing efforts and toward control of onchain infrastructure.

Under a control-based approach, founders could generate token value without triggering securities law, so long as the protocol operates independently and tokenholders retain ultimate control. The future of these policy developments is uncertain, but the direction is clear: the law is evolving to recognize that not all value-accruing efforts warrant securities regulation.

While some founders may prefer to build value in both tokens and equity, others may prefer a “one-asset” model where all value exists onchain and accrues to the token.

The one-asset model has two main advantages: it aligns incentives between the company and tokenholders, and it allows founders to focus entirely on making the protocol as competitive as possible. Its appeal lies in its simplicity, and some leading projects, such as Morpho, are already pursuing it.

As before, the securities analysis may depend on ownership and control — even more important for the one-asset model given the clear focus on driving all value to the token. To avoid creating a securities-like relationship, tokens must convey direct ownership and control of digital property. While legislation or rulemaking may eventually codify this approach, the primary challenge for the one-asset model today is regulatory uncertainty while clarity is still forthcoming.

In the one-asset model, the company should be structured as a nonprofit or nonstock entity with no equity, dedicated solely to supporting the protocol it built. At launch, the company should transfer ownership and control to tokenholders, ideally organized as a DUNA or similar legal entity designed for blockchain-based governance.

After launch, the company may wish to continue contributing to the protocol, but its relationship to tokenholders must not resemble that of an entrepreneur to its investors. Instead, tokenholders may empower the company as a delegate authorized to exercise certain powers, or as a service provider contracted to perform certain work. Both roles — delegate and service provider — are ordinary features of a decentralized ecosystem governed by tokenholders, and neither should automatically create a relationship that justifies applying securities law.

Founders should take care to differentiate tokens in a one-asset model from company-backed tokens such as FTT, which function far more like securities. Unlike tokens that convey ownership and control over digital property, company-backed tokens like FTT represent a claim on revenue generated by a company offchain. The value of a company-backed token lives and dies with the company — if the company performs poorly, tokenholders have no recourse, and if the company fails, the token becomes worthless.

Company-backed tokens create precisely the kind of asymmetry that securities law is designed to address. Tokenholders have no way to audit offchain revenue, override the company’s decisions, replace the company, or hire others to perform the same work. The key issue is power asymmetry — holders of company-backed tokens are hopelessly at the mercy of the company, which creates a securities-like relationship for which regulation may be appropriate. Founders pursuing a one-asset model must avoid structures that create asymmetries like this.

Companies that create tokens in a one-asset model may still want or need to generate offchain revenue to fund their operations, but that revenue should be used solely for expenses — not for dividends, buybacks, or other transfers to tokenholders. If needed, the company could also be funded directly by tokenholders through treasury grants, token inflation, or other means that tokenholders approve. Most importantly, tokenholders must always remain in control.

Founders may also raise other arguments for why the one-asset model should not trigger the securities laws. For example, founders who never sell tokens to the public may point to the absence of an investment of money, and founders who develop protocols involving no pooled assets or shared profits may point to the absence of a common enterprise. But none of these defenses — including that tokens do not create a securities-like relationship — offer certainty as to how current laws and regulations may apply.

This new era for crypto offers an exciting opportunity for founders, but it is still young, and many open questions remain.

One question is whether governance can be eliminated entirely without triggering securities regulation. In theory, tokenholders can own digital property without exercising any control. But if they are entirely passive, the relationship may begin to resemble the sort that securities law was meant to address, especially if the company retains some control. Future legislation or rulemaking may eventually validate a one-asset model with no governance, but founders must follow the law as it exists today.

Another question is how founders should approach initial funding and protocol development in a one-asset model. While the mature structure is relatively well-defined, the optimal path from startup to scale is less clear. If there is no equity for founders to sell, how will they raise capital to build infrastructure in the first place? How should they decide who receives tokens at launch? What legal entity type should they use, and should it evolve from one form to another over time? These and many other details are still unclear.

Alternatively, it’s possible that some tokens are best treated as onchain securities. The problem is that current securities regulation makes it nearly impossible for those tokens to function in a decentralized environment where they can benefit from public blockchain infrastructure. Ideally, Congress or the SEC would modernize securities law so that stocks, bonds, notes, investment contracts, and other securities can exist onchain and operate seamlessly alongside other digital assets. But until that happens, regulatory clarity for onchain securities may remain out of reach.

There is no single right answer for founders choosing how to structure tokens and equity — only tradeoffs in cost, benefit, risk, and opportunity. Many open questions will only be answered by experimentation as the market reveals what works best.

We wrote this piece to clarify the choices that founders face and the options that may emerge as crypto policy evolves. Since the inception of smart contract platforms, unclear laws and hostile regulations have kept founders from realizing the potential of blockchain-based tokens. The current regulatory environment has opened a new territory for exploration.

Above, we laid out a map to help founders navigate that territory, and we offered a few paths that we believe may lead to success. But the map is not the territory, and much remains to be discovered. We believe the next generation of founders will redefine what tokens can do. If you are an explorer and want help on the journey, we’d love to hear from you.

Thank you to Amanda Tuminelli (DeFi Education Fund), John McCarthy (Morpho Labs), Marvin Ammori (Uniswap Labs), and Miles Jennings (a16z crypto) for their thoughtful feedback on this article.

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